The accidental landlord reveals the best way to overcome a taxing problem

The Chancellor’s recent announcement that, from 2017, landlords will no longer get full tax relief on their mortgage interest payments has come as a blow. There are ways to sweeten the tax pill, but it may be easier to pay up...

Knocked for six would be a fair summary of how landlords feel about the Chancellor’s recent announcement that from 2017, we will no longer get full tax relief on our mortgage interest payments. Instead, relief will be gradually reduced down to the basic rate of income tax, currently 20 per cent, by April 2020.

A petition is doing the rounds to try to get George Osborne to change his mind, but the whisper on the wind is that he is showing no signs of wavering and instead is determined to tax us more heavily. He claims that only wealthier landlords will be affected by the recently announced changes, but that isn’t necessarily true, as some of us lower-rate taxpayers will also be tipped into the higher tax bracket because, in future, our mortgage interest payments will be excluded from our costs when our rental profit is determined. Instead, we’ll get a tax credit for our mortgage interest at the basic rate of tax.

Some less well-off landlords who are only just scratching a living will end up losing tax credits or child benefit, too, because their profits will seem higher than they really are.

So what can you do about it?
One option is to move rental property into a limited company structure and to take out the profits as dividends, as these are taxed less heavily than regular income. From April 2016, everyone can earn £5,000 in dividends free of tax, after which they will be taxed at 7.5 per cent, 32.5 per cent or 38.1 per cent, depending on whether they are a basic rate, higher rate or additional rate taxpayer. You can limit the amount you take out of the company in dividends each year to avoid ending up in a higher tax bracket. Also, some canny landlords have made their children shareholders and paid them dividends, as they also get a £5,000 tax-free allowance.

However, before you rush to set up a company, property tax specialist Michael Wright, of RITA4Rent (rita4rent.co.uk), warns that many of us might actually end up paying more tax than we would save by incorporating our rentals. For a start, those of us who have owned our properties for a while and seen them rise in value might have to pay capital gains tax of 18 per cent or 28 per cent on the capital growth (less allowances and allowable deductions) because we would effectively be ‘selling’ them to the company. On top of this, the company would have to pay stamp duty on any property worth more than £125,000.

Also, if you transfer a mortgaged property, you will have to pay off the loan and apply for a new company mortgage. This is doable, says broker Martin Stewart, of London Money, but it could be expensive. As there are far fewer lenders in this market, you might end up paying a higher interest rate.

Wright suggests that setting up a limited company to buy rental property might make more sense for new buy-to-let investors, although he points out that every case is different. A simpler solution for existing, higher-rate taxpayers who co-own a rental property with a lower-rate taxpayer might be to switch the majority of ownership to them, so they receive the bulk of the rental income. However, if you are thinking of going down this route, you should speak to a tax advisor to make sure you do it correctly and that you are sticking to HMRC rules.

As Wright says, there is no one-size-fits-all solution. I suppose some landlords will sell up, others will come up with smart solutions to sidestep the changes, while the rest of us will just have to swallow hard and hand over more tax.

Victoria Whitlock lets three properties in south London. To contact Victoria with your ideas and views, tweet @vicwhitlock